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Balance of Risk and Reward in Options Trading
You don’t need to be a trader or an investor to know that the higher the risk, the greater the reward. This concept is true in all aspects of life and business. The more risk you arewilling to undertake in life, the more life returns to you. Indeed, risk and reward aredirectly proportional and often in trading and investment, the more risk your account isexposed to, the greater the return on investment when things work out as planned.Knowing that risk and reward are proportional makes finding the correct balance of risk and reward extremely important to all kinds of traders; stock traders, futures traders,options traders etc. There is no one solution that works for everyone and the correct balance is decided upon the risk appetite and risk tolerance of the individual trader.For stock traders, balancing risk and reward primarily involves adjusting the amount of growth stocks and defensive stocks in one’s portfolio. Generally, the more growth or speculative stocks in one’s portfolio, the greater the risk due to greater uncertainty andtherefore the higher the gain when things works out as expected. The more defensivestocks in one’s portfolio, the more predictable returns become and therefore the lower thereturn as these stocks does not generally move a lot. This degree of risk / reward balancing is at best crude compared to the surgically fine degree of balancing you canhave in options trading.Stock options are the most versatile trading instrument in the world right now due to thewide array of options strategies that are employable. Yes, not only can risk and reward be balanced through employing different mix of strategies in your portfolio, there are alsodifferent risk and reward profiles achievable by each individual options strategy. Thereare options strategies that range from making over 1000% profit while risking all your money to options strategies that make a mere 0.01% return while risking nothing as wellas every centimeters in between.As long as you understand what your personal risk appetite and risk tolerance is, you will be able to find an options strategy that suits your needs 100%. Here’s a general outline of the kind of risk reward balance that can be achieved through options trading:Highest Risk, Highest Reward – OTM Call / Put buyingThis is the options strategy that produces the legendary 1000% profit that amazed somany beginners. What those ads did not tell you is that the risk is losing ALL the moneythat you put into the strategy. This options strategy involves buyingout of the moneycalloptions when you think a stock is going to go up or buying out of the money put options when you think a stock is going to go down. Professionals use thisoptions strategywithonly a very small portion of their money in order to place a bet on an uncertain eventsuch as leveraged buyout. Some lucky amateurs use this options strategy with all their money and then become millionaires overnight. The downside of this strategy is the factthat if the stock did not move far enough in the direction you expected it to, you can lose
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